[Senate Executive Report 104-35]
[From the U.S. Government Publishing Office]



104th Congress                                              Exec. Rept.
                                 SENATE

 2d Session                                                      104-35
_______________________________________________________________________


 
PROTOCOL AMENDING ARTICLE VIII OF THE 1948 TAX CONVENTION WITH RESPECT 
                      TO THE NETHERLANDS ANTILLES

                                _______
                                

               September 25, 1996.--Ordered to be printed

_______________________________________________________________________


   Mr. Helms, from the Committee on Foreign Relations, submitted the 
                               following

                              R E P O R T

                    [To accompany Treaty Doc. 104-23]

    The Committee on Foreign Relations, to which was referred 
the Protocol Between the Government of the United States of 
America and the Government of the Kingdom of the Netherlands in 
Respect of the Netherlands Antilles Amending Article VIII of 
the 1948 Convention with Respect to Taxes on Income and Certain 
Other Taxes as Applicable to the Netherlands Antilles, signed 
at Washington on October 10, 1995, having considered the same, 
reports favorably thereon, without amendment, and recommends 
that the Senate give its advice and consent to ratification 
thereof.

                               I. Purpose

    The current treaty in respect of the Netherlands Antilles 
generally provides an exemption from U.S. tax for interest from 
U.S. sources derived by a resident or corporation of the 
Netherlands Antilles. The purpose of the proposed protocol is 
to limit the continued applicability of this exemption in order 
to prevent treaty-shopping abuses pursuant to which residents 
of third countries inappropriately derive the benefit of the 
exemption from U.S. tax on U.S.-source interest. The proposed 
protocol preserves the exemption for interest on certain debt 
instruments that were issued on or before October 15, 1984, 
pursuant to financing arrangements that were structured in 
reliance on the existence of such exemption.

                             II. Background

    The Convention between the United States of America and the 
Kingdom of the Netherlands with Respect to Taxes on Income and 
Certain Other Taxes was signed on April 29, 1948 (``1948 
Convention''). The 1948 Convention was extended to the 
Netherlands Antilles by exchange of notes dated June 24, 1952, 
August 7, 1952, September 15, 1955, November 4, 1955, and 
November 10, 1955. The 1948 Convention as applicable to the 
Netherlands Antilles was amended by protocols signed on June 
15, 1955 and October 23, 1963.
    On June 29, 1987, the United States gave notice of 
termination of the 1948 Convention as it applied to the 
Netherlands Antilles. On July 10, 1987, the United States 
modified its notice of termination to provide that the 
termination did not apply to Article VIII (Interest) and 
certain ancillary provisions of the 1948 Convention. The United 
States' partial termination of the 1948 Convention as it 
applies to the Netherlands Antilles was due to concerns about 
treaty-shopping abuses in connection with the convention.
    In 1992, the United States and the Netherlands signed a new 
Convention for the Avoidance of Double Taxation and the 
Prevention of Fiscal Evasion with Respect to Taxes on Income 
(``1992 Convention''). The 1992 Convention, which entered into 
force on December 31, 1993, replaced the 1948 Convention. 
However, pursuant to its terms, the 1992 Convention does not 
affect the agreement extending the 1948 Convention to the 
Netherlands Antilles (as modified by the partial termination). 
The 1992 Convention does not extend to the Netherlands 
Antilles.
    The proposed protocol amending Article VIII of the 1948 
Convention in respect of the Netherlands Antilles was signed in 
Washington on October 10, 1995. The proposed protocol was 
transmitted to the Senate for advice and consent to its 
ratification on January 3, 1996 (see Treaty Doc. 104-23). The 
Committee on Foreign Relations considered the proposed protocol 
at its Committee business meeting on September 25, 1996.

                              III. Summary

    Article VIII of the 1948 Convention, as extended to the 
Netherlands Antilles, generally provides for an exemption from 
U.S. tax for interest (other than mortgage interest) from U.S. 
sources derived by a resident or corporation of the Netherlands 
Antilles that is not engaged in a trade or business in the 
United States through a permanent establishment. The proposed 
protocol amends Article VIII of the 1948 Convention to limit 
the exemption from U.S. tax to interest paid on debt 
instruments issued on or before October 15, 1984 by a U.S. 
person to certain related controlled foreign corporations.

                          IV. Entry Into Force

    The proposed protocol provides that it will enter into 
force upon the later of June 30, 1996 or the exchange of 
instruments of ratification. The proposed protocol further 
provides that if it has not entered into force prior to January 
1, 1997, it will not enter into force.

                          V. Committee Action

    The Committee on Foreign Relations considered the proposed 
protocol with respect to the Netherlands Antilles on September 
25, 1996, and ordered the proposed protocol favorably reported 
by a voice vote, with the recommendation that the Senate give 
its advice and consent to the ratification of the proposed 
protocol.

                         VI. Committee Comments

    The Committee on Foreign Relations believes that the 
proposed protocol with respect to the Netherlands Antilles is 
in the interest of the United States and urges that the Senate 
act promptly to give its advice and consent to ratification. 
The committee has taken note of certain issues with respect to 
the current treaty and proposed protocol, and believes that the 
following comments may be useful to U.S. Treasury officials in 
providing guidance on these matters.
    The committee continues to believe that the United States 
should maintain its policy of limiting treaty shopping 
opportunities whenever possible. The anti-treaty-shopping 
provisions of the 1948 Convention as applicable to the 
Netherlands Antilles are not considered adequate. The United 
States' partial termination of the 1948 Convention as it 
applies to the Netherlands Antilles was due to concerns about 
treaty shopping abuses with respect to the convention. The 
committee commends Treasury on the proposed protocol which 
further limits the potential for treaty shopping abuses with 
respect to the Netherlands Antilles and bolsters the ability to 
negotiate effective anti-treaty-shopping provisions in treaties 
with other countries.

                           VII. Budget Impact

    The committee has been informed by the staff of the Joint 
Committee on Taxation that the proposed treaty is estimated to 
have a negligible effect on annual Federal budget receipts 
during the fiscal year 1997-2003 period.

                 VIII. Explanation of Proposed Protocol

    A detailed, article-by-article explanation of the proposed 
protocol with respect to the Netherlands Antilles is set forth 
below.

                               Article I

    Article I of the proposed protocol amends Article VIII of 
the 1948 Convention to limit the exemption from U.S. tax for 
U.S. source interest paid to residents of the Netherlands 
Antilles. Under the amendment, the exemption applies only to 
interest paid with respect to debt instruments issued on or 
before October 15, 1984, to a related controlled foreign 
corporation which was in existence before October 15, 1984, and 
the principal purpose of which is the issuing of debt 
obligations or the holding of short-term obligations and the 
lending of the proceeds of such obligations to affiliates.
    According to the Treasury Department's Technical 
Explanation (hereinafter referred to as the ``Technical 
Explanation''), U.S. tax principles generally will apply for 
purposes of determining whether a debt instrument was issued on 
or before October 15, 1984. In this regard, the Technical 
Explanation provides that the principles of Rev. Rul. 85-163, 
1985-2 C.B. 249, will apply to treat any debt instrument issued 
after October 15, 1984, pursuant to a binding written agreement 
entered into on or before such date as having been issued on or 
before such date, including a debt instrument issued upon the 
exercise of a warrant or the conversion of a convertible 
obligation if such warrant or convertible obligation was issued 
on or before such date. The Technical Explanation further 
states that the principles of section 957 of the Internal 
Revenue Code will apply in determining whether a Netherlands 
Antilles company is a controlled foreign corporation and the 
principles of Code section 482 will apply in determining 
whether any person is an affiliate of a controlled foreign 
corporation.
    Some U.S. companies established subsidiaries in the 
Netherlands Antilles in order to issue debt in the 
international capital markets. Under this structure, the 
Netherlands Antilles subsidiary issued so-called Eurobonds in 
the international market. The Netherlands Antilles subsidiary 
then loaned the proceeds of these Eurobonds to its U.S. parent 
or to another U.S. affiliate. The U.S. parent or affiliate thus 
issued to the Netherlands Antilles subsidiary a debt obligation 
that corresponded to the Eurobonds issued by the subsidiary. 
The Netherlands Antilles subsidiary receives interest from the 
U.S. parent or affiliate on the debt obligation of such parent 
or affiliate and pays interest on the Eurobonds it issued. The 
Netherlands Antilles subsidiary relies on Article VIII of the 
1948 Convention as extended to the Netherlands Antilles in 
order to avoid the U.S. 30-percent withholding tax on the 
interest received from the U.S. parent or affiliate. The 
interest paid by the Netherlands Antilles subsidiary on the 
Eurobonds is not subject to any tax by the Netherlands 
Antilles.
    This structure for the international issuance of debt was 
used by U.S. companies prior to the enactment of the Deficit 
Reduction Act of 1984 (``1984 Act''). Before its amendment by 
the 1984 Act, the U.S. 30-percent withholding tax applied to 
all U.S.-source interest income of nonresident alien 
individuals and foreign corporations (other than interest on 
bank deposits and short-term original issue discount). Thus, 
interest paid to foreign persons on a debt obligation of a U.S. 
company generally was subject to this 30-percent withholding 
tax. Although U.S. tax treaties contained provisions that would 
reduce or eliminate this U.S. withholding tax, the Committee 
understands that the procedures for claiming the benefits of a 
tax treaty were too cumbersome for use in connection with a 
public offering of debt. Accordingly, U.S. companies were 
effectively precluded from issuing debt directly in the 
international capital markets.
    The 1984 Act provided an exception from the U.S. 30-percent 
withholding tax for interest on certain portfolio debt 
obligations that enabled U.S. companies to issue international 
debt offerings directly. This exception applies to (1) certain 
obligations issued in bearer form pursuant to procedures 
designed to ensure that the obligations are held only by non-
U.S. persons and (2) certain obligations issued in registered 
form for which the payor has received a statement that the 
beneficial owner of the obligation is not a U.S. person. 
Pursuant to one of several specified limitations, this 
exception does not apply to interest paid to a controlled 
foreign corporation by a related person. This exception is 
effective for interest received after July 18, 1984 (the date 
of enactment of the 1984 Act) with respect to obligations 
issued after such date.
    In connection with the enactment of this exception, the 
1984 Act included a special rule with respect to certain 
interest paid in connection with back-to-back obligations of 
the type described above. Under this rule, interest paid on an 
obligation of a U.S. person to a related controlled foreign 
corporation is treated for tax purposes as paid to a resident 
of the country in which the controlled foreign corporation is 
incorporated. In addition, it was intended under this rule that 
the corresponding obligation of the controlled foreign 
corporation be recognized as an obligation of the controlled 
foreign corporation. See Joint Committee on Taxation, General 
Explanation of the Revenue Provisions of the Deficit Reduction 
Act of 1984 (JCS-41-84), December 31, 1984, p. 397. This 
special rule applies only to interest paid on obligations 
issued before June 22, 1984 (the date of conference action on 
the 1984 Act) to a controlled foreign corporation that was in 
existence on or before such date. In order to be eligible for 
this special rule, the controlled foreign corporation must 
satisfy certain other requirements, including a requirement 
that the principal purpose of the controlled foreign 
corporation be the issuance or holding of debt obligations and 
the lending of the proceeds thereof to affiliates and a 
requirement that the debt-equity ratio of the controlled 
foreign corporation be not more than a specified ratio.
    On October 15, 1984, the Internal Revenue Service published 
Rev. Rul. 84-153, 1984-2 C.B. 383, which specifically addresses 
the applicability of the exemption under Article VIII of the 
1948 Convention in the case of this type of back-to-back 
financing arrangement. The ruling provides that a Netherlands 
Antilles subsidiary that participates in this type of 
arrangement and that is not eligible for the special rule 
provided in the 1984 Act is considered a mere conduit; as such, 
the interest payments to such subsidiary are not eligible for 
the exemption from U.S. tax under Article VIII of the 1948 
Convention.
    The requirements for continued exemption under the proposed 
protocol basically mirror the requirements of the special rule 
provided in the 1984 Act. However, the proposed protocol 
reflects the October 15, 1984, date on which the IRS revenue 
ruling was published rather than the June 22, 1984, date of the 
1984 Act rule. The Technical Explanation states that 
application of the continued exemption to debt instruments 
issued on or before October 15, 1984, reflects the Internal 
Revenue Service practice of extending the 1984 Act rule to debt 
instruments issued on or before the date the revenue ruling was 
published. The Technical Explanation further notes that 
although the proposed protocol does not explicitly condition 
the continued exemption on satisfaction of all of the 
requirements specified in the 1984 Act rule, failure to satisfy 
such requirements (e.g., failure to meet the specified debt-
equity ratio requirement) generally will result in the 
controlled foreign corporation being treated as a mere conduit 
that is not eligible for the benefits of Article VIII of the 
1948 Convention.

                               article ii

    Article II of the proposed protocol provides that the 
proposed protocol is subject to ratification in accordance with 
the applicable procedures of the United States and the 
Netherlands. The proposed protocol provides that it will enter 
into force upon the later of June 30, 1996, or the exchange of 
instruments of ratification. The proposed protocol further 
provides that it will not enter into force at all if it has not 
entered into force prior to January 1, 1997.

                 IX. Text of Resolution of Ratification

    Resolved, (two-thirds of the Senators present concurring 
therein), That the Senate advise and consent to the 
ratification of the Protocol Between the Government of the 
United States of America and the Government of the Kingdom of 
the Netherlands in Respect of the Netherlands Antilles Amending 
Article VIII of the 1948 Convention with Respect to Taxes on 
Income and Certain Other Taxes as Applicable to the Netherlands 
Antilles, signed at Washington on October 10, 1995 (Treaty Doc. 
104-23).
                                APPENDIX

                              ----------                              


 Written Statement of Joseph H. Guttentag, International Tax Counsel, 
 Department of the Treasury Before the Committee on Foreign Relations, 
                    U.S. Senate, September 24, 1996

    Mr. Chairman and Members of the Committee: I am pleased to 
submit this statement on behalf of the Administration to 
recommend favorable action on the protocols to two tax 
treaties, with Indonesia and with the Netherlands with respect 
to the Netherlands Antilles, that are on the Committee's 
business meeting agenda. Also on the agenda is the tax treaty 
with Kazakhstan, on which the Administration recommended 
favorable action in testimony before the Committee on June 13, 
1995. There are also three additional bilateral tax treaties 
that the President has transmitted to the Senate, with Austria, 
Luxembourg, and Turkey. All these agreements provide 
significant benefits to the United States, as well as to our 
treaty partners. Treasury appreciates the Committee's interest 
in these agreements, and requests the Committee and the Senate 
to take favorable action at this time on the three agreements 
that are on the Committee's agenda, and on the remaining three 
treaties as soon as possible.
    The tax treaty program is designed to remove obstacles to 
international trade and investment, such as double taxation, 
and to prevent fiscal evasion, such as through treaty shopping 
and information concealing. Accordingly, tax treaties provide 
substantial benefits to taxpayers as well as to the fiscs of 
both treaty partners.
    For example, high withholding taxes at source are an 
impediment to international economic activity. Under United 
States domestic law, all payments to non-United States persons 
of dividends and royalties as well as certain payments of 
interest are subject to withholding tax equal to 30 percent of 
the gross amount paid. Inasmuch as this tax is imposed on a 
gross rather than net amount, it imposes a high cost on 
investors receiving such payments. Indeed, in many cases the 
cost of such taxes can be prohibitive. Most of our trading 
partners impose similar levels of withholding tax on these 
types of income.
    Tax treaties alleviate this burden by reducing the levels 
of withholding tax that the treaty partners may impose on these 
types of income. In general, United States policy is to reduce 
the rate of withholding taxation on interest and royalties to 
zero. Dividends normally are subject to tax at one of two 
rates, 15 percent on portfolio investors and 5 percent on 
direct corporate investors, with certain exceptions.
    The Treasury Department has included in all its recent tax 
treaties comprehensive ``limitation on benefits'' provisions 
that limit the benefits of the treaty to bona fide residents of 
the treaty partner. These provisions are not uniform, as each 
country has its own characteristics that make it more or less 
inviting to treaty shopping in particular ways. Consequently, 
each provision must to some extent be tailored to fit the facts 
and circumstances of the treaty partners' internal laws and 
practices. Moreover, these provisions should be crafted to 
avoid interfering with legitimate and desirable economic 
activity. For example, in the future we plan to address 
directly in our negotiations the issue of how open-end United 
States regulated investment companies (RICs) should be treated 
under limitation on benefits provisions in order to facilitate 
cross-border investments from this important source of capital. 
Because these funds are required to stand ready to redeem their 
shares on a daily basis, we believe they generally should be 
entitled to treaty benefits to the same extent as closed-end 
RICs, which qualify for benefits, under standard limitation on 
benefits provisions because they are publicly traded on stock 
exchanges. However, the extent to which this goal may be 
achieved is likely to vary from treaty to treaty, as the 
negotiators need to ensure that mutual funds established in the 
treaty partner cannot be used to promote treaty shopping.
    Our tax treaties and treaty positions are subject to 
continual review. We reexamine the appropriateness and 
effectiveness of our treaty provisions, and receive comments 
from both public and private sources. The release last week of 
the new U.S. model income tax treaty, copies of which were 
provided to the Committee, is an important step in this process 
but does not represent its conclusion. The new model represents 
our favored treaty positions at this time; we will reevaluate 
and update the model over time as we evaluate model treaty 
positions as employed in our recent tax treaties and receive 
comments and further suggestions on the model itself.

discussion of pending agreements--indonesia, netherlands antilles, and 
                               kazakhstan

    I would like to discuss the importance and purposes of each 
agreement that the Committee has set for consideration. We have 
submitted Technical Explanations of each agreement that contain 
detailed discussions of each treaty and protocol. These 
Technical Explanations serve as an official guide to each 
agreement. We have furnished our treaty partners with a copy of 
the relevant technical explanation and offered them the 
opportunity to submit their comments, suggestions and 
concurrence.

Indonesia

    The proposed protocol with Indonesia, which was signed at 
Jakarta on July 24, 1996, amends the income tax treaty with 
Indonesia that was signed in 1988 and entered into force on 
December 30, 1990. In many cases, the withholding tax rates 
permitted under the existing tax treaty with Indonesia 
significantly exceed those found in Indonesia's treaties with 
other OECD countries. This places United States business at a 
substantial competitive disadvantage in Indonesia relative to 
competitors from other industrialized countries. Because 
Indonesia is one of the world's most populous countries, with a 
rapidly expanding market that is located in a region of dynamic 
economic growth, it is especially important that United States 
firms be able to compete there without this disadvantage.
    The proposed protocol achieves this objective by reducing 
the withholding tax rates permitted to bring them into line 
with those in Indonesia's recent treaties with other OECD 
countries. The protocol reduces the maximum rates of tax on 
direct-investment dividends, interest, and royalty income, 
which are generally 15 percent under the current treaty, to 10 
percent.

Netherlands Antilles

    Many years ago, the United States and the Netherlands 
agreed to extend the then treaty between them to the 
Netherlands Antilles. The extension became a contentious issue, 
and in 1987 most of the provisions of the treaty as extended to 
the Netherlands Antilles were terminated, except for the 
taxation of interest at source and ancillary provisions. The 
proposed protocol to the Netherlands treaty relates only to the 
Netherlands Antilles and would complete the termination by 
eliminating the exemption from United States withholding tax 
for interest, except with respect to certain grandfathered debt 
instruments.
    The proposed protocol relating to the Netherlands Antilles 
would eliminate ongoing treaty shopping through the Netherlands 
Antilles by limiting the exemption from United States 
withholding tax to certain debt instruments issued on or before 
October 15, 1984. These debt instruments were issued in 
connection with Eurobond offerings by Netherlands Antilles 
subsidiaries of United States companies, generally before the 
Deficit Reduction Act of 1984 allowed United States companies 
to issue debt, free of United States withholding tax, directly 
into the international capital markets. It is appropriate to 
provide a continued exemption for these debt instruments 
because the Eurobonds were issued in reasonable reliance on the 
continued existence of the exemption and it is believed that 
eliminating the exemption entirely would have an adverse effect 
on international capital markets.

Kazakhstan

    In addition to the five new treaties and protocols, the 
Committee still has under consideration a treaty between the 
United States and Kazakhstan. This treaty was the subject of a 
hearing last year. At our request, the Committee delayed its 
vote on this treaty until we received adequate assurances from 
the Government of Kazakhstan regarding access to bank account 
information. At the time of last year's hearing, Kazakhstan had 
recently adopted laws permitting the opening of anonymous bank 
accounts, and we wanted to be certain that the existence of 
these accounts would not, as a legal or a practical matter, 
impede our access to bank account information in order to 
enforce our tax laws.
    I am pleased to report that Kazakhstan is now clearly 
moving away from bank secrecy. The Government of Kazakhstan has 
submitted legislation to the Kazakhstan Parliament to repeal 
the earlier laws permitting the establishment of anonymous bank 
accounts. We understand that the lower house of the Kazakhstan 
Parliament has passed the legislation and that the Government 
of Kazakhstan expects the law to be enacted without opposition 
this week.
    We appreciate the Committee's support on this very 
important issue and hope that we can work cooperatively to move 
this treaty forward while at the same time protecting the 
integrity of the treaty's exchange of information provisions. 
One alternative that we would support is for the Committee to 
report the treaty recommending that the Senate give its advice 
and consent to ratification assuming Kazakhstan's adoption of 
the new law. The full Senate then could approve the 
recommendation with appropriate conditions concerning the 
elimination of anonymous bank accounts. We have provided the 
Committee with the latest information we have regarding the 
status of this issue and will continue to keep the Committee 
advised. If the Senate chooses to give its advice and consent 
to the treaty at the present time, the Administration is 
willing and able to accept the responsibility of not permitting 
instruments of ratification to be exchanged until it is fully 
satisfied that the conditions described above have been fully 
satisfied. Absent this procedure, entry into force of the 
treaty could be further substantially delayed. Based on 
information we have received it would be in the interest of the 
United States to have the treaty enter into force as promptly 
as possible.
    We will continue to work with the Committee and its staff 
to bring this issue to a mutually satisfactory conclusion.

                               conclusion

    Let me conclude by again thanking the Committee for its 
continuing interest in the tax treaty program. We appreciate 
the assistance and cooperation of the staffs of this Committee 
and of the Joint Committee on Taxation in the tax treaty 
process. With your and their help, we have over the past 
several years brought into force 19 new treaties and protocols.
    We urge the Committee to take prompt and favorable action 
on the three agreements before you at the business meeting. We 
further urge the Committee to take favorable action as soon as 
possible on the remaining three tax treaties that the President 
has submitted to the Senate. Such action will send an important 
message to our trading partners and our business community. It 
will demonstrate our desire to expand the United States treaty 
network with income tax treaties formulated to enhance the 
worldwide competitiveness of United States companies. It will 
strengthen and expand our economic relations with countries 
that have seen significant economic and political changes in 
recent years. Finally, it will make clear our intention to deal 
bilaterally in a forceful and realistic way with treaty abuse.